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By Dr. Jim Dahle, WCI Founder
Long-term readers know that for the last six years, we have been investing a small portion (20%) of our portfolio into real estate and a fraction (25% or 5% of the whole portfolio) of that portion into private lending funds. I have written previously about these funds, but briefly, they collect money from investors and lend it out to real estate operators. They pay the operators’ expenses, take their fees, and share the remainder of the profits with the investors. The investor gets a high-yielding, passive investment of dozens of real estate-backed loans.
As an investment, the returns tend to be relatively high (stock-like) and quite steady but terribly tax-inefficient. The main risk, besides manager risk, is simply that the debt fund becomes an equity fund in a terrible real estate downturn when the operators mail in the keys instead of the payments due.
Private or Public Real Estate Investments?
There are public companies and REITs that do the same thing and trade on the stock market. You can even buy an iShares ETF of these companies. Like anything traded on the stock market, the returns of these public investments tend to be more correlated with the overall market and display more volatility. While the underlying source of returns is the same, there is more of a speculative component introduced—at least in the short run—due to the company being marked to market each day. As I write this, the yield on this ETF is nearly 10%, but that’s dramatically higher than it was before it lost more than 27% of its value in 2022. If you don’t like that sort of volatility, you may prefer to invest on the private side.
More information here:
The Case for Private Real Estate
Comparing Private Real Estate Lending Funds
Today, I thought I would compare seven different private real estate lending funds from four different companies. This is not a comprehensive list of these funds. It is, however, a list that includes all of the funds I have invested in and the funds offered by our real estate partners (i.e. advertisers). One fund will remain unnamed at the request of the fund manager (don’t ask me why). The funds we will be talking about include:
Here is a chart comparing the funds to each other, as of April 2023.
As you can see, there is a lot to know before you invest. However, given the straightforward nature of the business and the relatively high liquidity of these funds, they might be the easiest private investments on which to do due diligence.
None of these funds are particularly old. If you’re looking for a track record similar to the 95-year-old Vanguard Wellington Fund, you can give up right now. Between 10-15 years is pretty good in this space. Most of the collateral for these loans is apartment buildings, no matter what fund you invest in. The funds all hold dozens but usually not hundreds of loans. You will find significant variation in the percentage of the fund that is invested in first lien position. That means you are the senior lender on a project, so if everything goes to Hades in a handbasket, you should be the first one to get your money back. The fund has the ability to foreclose on the property. Obviously, if you’re going to take on the risk of not being in first lien position, you should get paid more to do that. The funds also have some variation in how much they will loan on a given project and how much leverage is used in the fund itself. That percentage of leverage used ranges from 0% to as much as 60% at times. The amount in the chart above is what they reported to me was actually being used in early 2023.
You may or may not care how often the fund pays you or how much liquidity it offers. Most of the funds have a 1-2 year lock-up but then will let you have your money back with 3-4 months of notice. Note that these partnership agreements usually include a provision that allows the fund to restrict withdrawals in exceptional circumstances (think Michael Burry in The Big Short).
Returns vary between 6%-16%, but they’re pretty steady year to year. I generally expect 7%-11% out of these funds. Most of them have adopted a REIT structure, which allows you to…
Read More: Comparing Private Real Estate Lending Funds